Quick Thoughts: Google Back on Track

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–          GOOG posted an excellent 3Q13 – ex MOT sales were up 18.9% YoY and net of TAC up 22.6% – bouncing back from the 2Q13 miss in a strong web ad market

–          Profitability was particularly strong. EPS beat by 4%, up 21% YoY. TAC as a % of ad sales was just 23.7%, lowest in 2 yrs and down 180bp YoY.

–          CPC was off another 4% QoQ and 8% YoY, but overshadowed by big ad volumes. Enhanced Campaigns are a work in progress, but should stabilize CPC

–          Ad monetization – search, video, mobile, etc. – all clicking while GOOG invests in world leading infrastructure, global penetration, and new services.

Google followed its 2Q13 whimper with a bang, handily beating consensus expectations for sales, EPS, ad sales, traffic acquisition costs (TAC), and paid clicks. The exodus of ad dollars from traditional media to the internet is continuing with no signs of a slowdown, with Google’s advertising take sustaining a near 19% growth rate despite competition from rising platforms like FB and TWTR, and resurgence from the likes of YHOO and AOL. While the over scrutinized Cost per Click (CPC) metric was down another 4% sequentially and 8% YoY, the overwhelming tide of good news had shares up more than 8% in the aftermarket.

The ad business was the biggest positive. Google sites revenue was up 22% YoY and 6% QoQ. Google also reported impressive growth around YouTube video ads with 75% year over year growth and 40% of traffic coming from mobile up from 6% two years ago.  The company also reined in its traffic acquisition costs (TAC) and reported its lowest TAC as a percent of ad revenue since 3Q2011. In terms of ad performance metrics, cost per click, which has been trending downward since 4Q2011, was offset by robust growth in paid clicks. Google also reported positive acceptance of its enhanced campaigns tool which allows advertisers to build a single ad campaign across platforms and incorporate location based and click-to-call features within mobile ads. While it didn’t break out any contribution metrics from the new tool, Google executives on the call did mention advertisers have increased the frequency of bidding and advertisers embracing the value of mobile. We believe enhanced campaigns have the potential to stabilize declining CPCs.

In contrast, Motorola Mobility has been declining as a source of revenue for Google, down -34% YoY to $1.18B for 3Q13. The unit reported an operating loss of $248M for the quarter, worse still than last year’s loss of $192M. Though Motorola is still a big drain, downsizing should bring losses lower. Google cut headcount at Motorola from 17,428 to 4,259 largely due to the divestiture of the set top box business to Arris group. But there is a glimmer of hope at its handset business. The new Moto X handset released last quarter has received decent reviews, in particular for its unusually robust battery life. I’m currently carrying a Droid Maxx, which employs some of the same power saving technology along with a capacious 3500Mah battery, and will proselytize from the rooftops about the joy of no longer worrying if my battery will run out before the end of the day. ABI research has picked up on the same theme, and it seems possible that word of mouth around the extraordinary life between charges could see demand picking up with time.

Also notable for the quarter was an acceleration in CAPEX spending at $2.29B up from $1.6B in 2Q 2013 and $872M in 3Q 2012. Infrastructure, driven by its network of data centers, is everything for Google. No company or organization in the world comes close to matching the computing power harnessed by Google’s multi-million server cores and its state of the art proprietary applications and systems that include: “Caffeine,” “Colossus,” “Percolator,” Pregel,” “Dremel,” “Spanner,” and “TruTime” among others. Google has drawn the best and brightest computer scientists from institutions like MIT, Cal Tech, and Stanford that are not only working on making Google’s computing infrastructure better, but also “moonshot” projects that can potentially change everyday life beyond what Google has already done. Google’s Glass and self-driving car are likely going to turn into real businesses in the future. It’s Calico project aimed at studying genetic causes of human aging and disease could benefit medical research and open new markets in healthcare. Google already demonstrated a genome app in June 2012 that summoned 600,000 processors and was able to decode the human genome in seconds. Where ever there is a problem, we can certainly expect Google to dedicate some computing power to solve it.

Google has also quietly expanded into new businesses such as digital content, hardware, and the enterprise. Excluding Motorola, non-ad revenue stood at nearly 9% this quarter up from about 5% last year. Its Google Play store can distribute content to over 1B Android enabled devices while YouTube is acquiring original content and is rumored to be a contender for the NFL’s Sunday ticket rights. The Chromecast is the lowest priced streaming device on the market and has stood atop Amazon’s best selling items for the last couple months. It already offers the highest performance cloud infrastructure and has plenty of runway in the enterprise with Docs.  Its current suite of consumer products, e.g. Search, Android, YouTube, Google+, Maps, Local, etc is synergistic for the future. Google has lots of ways to monetize in the long term and enjoys massive advantages over rivals such as Apple, Microsoft, and Amazon. Of all the technology companies in the world, none is better positioned in this current paradigm shift than Google.

For our full research notes, please visit our published research site.

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